The Push for Sequester Cuts

Republicans in Congress have decided to reject economists, the Congressional Research Service, and the International Monetary Fund, in order to argue that the sequestration cuts will be good for the economy.

To do this, they also misstate Keynesian economics, and they attack Keynesianism by describing a straw man and by then saying that this straw man is Keynesian economics, even though the economic theory they’re attacking originated nearly two centuries before Keynes was even born.

Republican Congressman Kevin Brady of Texas is the new Chairman of the Joint Economic Committee of Congress, and he is leading the Republicans’ charge on this. In the Republican magazine National Review, he headlined on February 21st, “What Kind of Cuts Grow the Economy?” (which assumes that some kind of cuts do “Grow the Economy”), and he argued that, “Time and again, economic studies have shown that countries that reduce their government deficits through spending cuts – rather than tax increases – can boost economic growth and job creation even in the short term.” He cited as his source there the report that his own office had produced for the Joint Economic Committee Republicans, “Spend Less, Owe Less, Grow the Economy,” which was dated 15 March 2011.

However, he ignored the much more recent report from the Congress’s own nonpartisan research arm, the Congressional Research Service, which was dated 11 January 2013 and titled “Can Contractionary Fiscal Policy Be Expansionary?” which stated boldly, “This view [Brady’s] contrasts with that held by most economists and found in conventional models. In those models, cutting spending will contract the economy. Chairman Bernanke of the Federal Reserve was referring to this view when he cautioned against large and immediate spending cuts.”

The CRS study (which Brady and other Republicans ignore) went on to cite grave deficiencies in the studies that Brady was relying upon. For example, the CRS report noted that a 2010 study from the IMF, “Macroeconomic Effects of Fiscal Consolidation,” which was much more comprehensive than the chief study that Brady’s report had relied upon (which was issued in 2009), obtained results that “are consistent with the mainstream view of fiscal policy” and it found “that deficit reduction has a contractionary effect on output, with deficit reduction equal to 1% of GDP reducing output by 0.5% of GDP.” Furthermore, “Some recent analyses have questioned the applicability of Alesina and Ardagna’s findings [the findings in the 2009 study upon which Brady’s JECR report had chiefly relied] to the current U.S. fiscal situation.”

Moreover, the IMF itself had previously been prejudiced against Keynesianism, and now even admitted it, and basically apologized for that. On 5 January 2013, I headlined, at businessinsider, “The IMF Admits It Was Wrong About Keynesianism,” and I linked there to the new “IMF Working Paper” from their chief economist Olivier Blanchard with Daniel Leigh, titled “Growth Forecast Errors and Fiscal Multipliers.” Their new study found that the IMF had systematically and consistently underestimated the Keynesian multiplier, and had thus wrongly assumed the correctness of conservative economists’ rejection of Keynesianism. Their comprehensive new study confirmed Keynesianism: “We find that, in advanced economies, stronger planned fiscal consolidation [commonly called ‘austerity,’ the opposite of Keynesianism] has been associated with lower growth than expected.” But such “austerity” was now being sought by congressional Republicans.

And this new IMF study wasn’t isolated, either. In August 2012, the International Labour Office in Geneva had issued “Macroeconomic Policy Advice and the Article IV Consultations: A Development Perspective,” and their study showed that: “The ‘one size fits all’ approach” that the IMF had previously been using, which targets low government spending as being a country’s way out of debt “has an uneasy existence with the empirical literature,” which proves that it doesn’t work. Then, in January 2013, the Center for Economic and Policy Research titled a study “Macroeconomic Policy Advice and the Article IV Consultations: A European Union Case Study,” and found that austerity (“fiscal consolidation”) failed not only with underdeveloped nations but also with EU nations.

Keynesianism was overwhelmingly affirmed, all over the place; all conservative economists should have been fired, they were proven to have been wrong; but instead congressional Republicans just dig in their heels, along with the ever-shrinking minority of ultra-conservative economists, who still favor anti-Keynesian policies, which are justified by bad (and mostly old) studies.

Even when Brady’s Joint Economic Committee Republicans issued in March 2011 their “Spend Less, Owe Less, Grow the Economy,” the main studies they had been relying upon were already discredited and out-of-date. The IMF issued in October 2010, a “World Economic Outlook,” whose entire third chapter was devoted to “Macroeconomic Effects of Fiscal Consolidation.” This summary of the research said: “Based on a historical analysis of fiscal consolidation in advanced economies, … it finds that fiscal consolidation typically reduces output and raises unemployment in the short term,” which causes the taxes that are coming into the government to go down, which causes the government’s deficits and debt to rise in the long term (thus failing at everything). “Fiscal consolidation typically has a contractionary effect on output. … When interest rates are stuck at zero [as they then were], the output cost of fiscal consolidation doubles. … During this time, the central bank is powerless to offset the slump in aggregate demand and inflation induced by the cut in government spending. The resulting fall in inflation raises the real interest rate, which in turn exacerbates the decline in aggregate demand, amplifying the short-term contractionary effect.”

During the following months, more such evidence poured in. A July 2011 “IMF Working Paper” by Guajardo, Leigh and Pescatori, was titled “Expansionary Austerity: New International Evidence,” and it concluded: “Our main finding that fiscal consolidation is contractionary holds up [even] in cases where one would most expect fiscal consolidation to raise private domestic demand,” so that “Expansionary Austerity” was basically just a right-wing myth. At around the same time, Roberto Perotti’s “The ‘Austerity Myth’: Gain Without Pain?” reported at the Bank for International Settlements that, “These results cast doubt on at least some versions of the ‘expansionary fiscal consolidation’ hypothesis, and on its applicability in the present circumstances.” In September 2011, the IMF issued yet another study, “Painful Medicine: … Slamming on the brakes too quickly will hurt incomes and job prospects.” It found: “The pain is not borne equally. Fiscal consolidation reduces the slice of the pie going to wage earners.”

On 18 July 2011, economist Mark Thoma headlined to summarize “The Crumbling Case for Austerity,” and economist Chad Stone bannered “The Crumbling Case for Cutting Spending to Stimulate the Economy.” The matter was essentially closed, even as of 2011. Republicans were just lying, in the same old vein. To cut government spending during a non-expansionary economy – which Republicans especially say that this economy is – would be economic suicide. But this is what Republicans want to do.

Perhaps in order to provide another means of repudiating Keynesianism so as to embrace the sequester cuts, Brady’s “Spend Less, Owe Less, Grow the Economy” report also misrepresented what Keynsianism itself actually is. His summary of the “Keynesian View” didn’t even so much as mention the Keynesian “multiplier,” which is at the core of Keynesian economics, and which the new IMF study, “Growth Forecast Errors and Fiscal Multipliers,” had examined in detail, and had re-estimated upward, when it concluded that the IMF itself had previously underestimated the effectiveness of Keynesian policy – which depends upon there being a large “multiplier effect” from deficit spending on infrastructure and other government investments.

Rather than so much as even just mentioning the “multiplier,” Brady’s report simply assumed that Keynesianism relies instead upon the discredited theory that, as he put it, “additional government debt ‘crowds out’ private investment through a higher real interest rate.” However, that “crowding out” theory actually goes back instead at least as far as Malachy Postlethwayt’s 1757 Great Britain’s True System, which stated: “The national Debts first drew out of private Hands, most of the Money which should, and otherwise would have been lent out to our skillful and industrious Merchants and Tradesmen: this made it difficult for such to borrow any.” The “crowding out” theory had nothing to do with Keynesianism, which was first formally introduced into economics in 1936, in John Maynard Keynes’s The General Theory of Employment, Interest and Money.